In the United States, exchange-trading of options has existed in a standardized, regulated marketplace since the 1970's. An option is essentially a contract giving a buyer the right, but not the obligation, to buy or sell shares of an underlying security at a specific price for a specific time. Since the 1970's a number of exchanges have been formed, including the Chicago Board Options Exchange (the “CBOE”), the American Stock Exchange (the “AMEX”), the Pacific Stock Exchange (the “PCSE”), the International Securities Exchange (the “ISE”), and the Philadelphia Stock Exchange (the “PHLX”). In general terms, four specifications describe an options contract: the type of the option (e.g., a put or a call), the premium (or the initial amount paid on the contract), the underlying security (or the security, such as an equity, which must be delivered or purchased if the option is exercised), and a contract expiration date.
Unlike other exchange-traded securities, which can generally be traded on equal terms at any exchange, many options trade differently at different exchanges. The variations can include differences in price, execution time, liquidity, etc. For example, an option whose underlying security is IBM, Corp. stock may be traded on several exchanges, however, there may be slightly different order pricing and execution characteristics associated with trades at different exchanges. IBM options at the ISE, for example, may be trading at the National Best Bid and Offer (“NBBO”—a dynamically updated price which shows a security's highest bid and lowest offer among all exchanges and market makers registered to trade in that security), while IBM options at the AMEX may be slightly higher than the NBBO.
In the future, it is possible that each of the different exchanges will enter into linkage agreements; however, until then this fragmented market continues to make it difficult for options customers to obtain best execution of their orders. The fragmented market also makes it difficult for customers to assess the overall quality of execution of their orders. The Securities and Exchange Commission (SEC) imposes a general duty on brokers to their customers to provide a duty of “best execution”. While the SEC does not explicitly define best execution, for a particular options trade the duty generally requires that the trade be executed on the most favorable terms available for the trade among all of the options exchanges at the time of the trade. It would be desirable to provide a system to monitor and evaluate option trade activity which overcomes deficiencies associated with existing trading systems.